How to Use Cyclical Analysis to Trade the Right Market Sector (Part 2)

One cannot point to any one factor that has directly caused bull market runs of the last two decades to be longer in duration than those during previous decades, but between the growth of emerging markets and developing countries and population growth it is not hard to figure out why we have seen such a rapid growth in price moves and stock market trends.

In my third book titled Forex Conquered, on page 37, I gave a graph showing the cyclical rotation for the sectors that perform during the various stages of an economic cycle. This is shown here in figure 1.

Figure 1

As the economy moves from a bear market or contraction period to a bull market or the early expansion stages, notice that the strong sectors are the Financials, the Transportation and Technology that leads the way as overall performance in the economy improves. This would suggest that one might want to start investing in those sectors perhaps by using sector Exchange Traded Funds (ETF's) such as the NASDAQ 100 or the QQQ's for technology leadership, or one can take a position in the CME groups mini-NASDAQ contract (NQ).

As for a sector ETF, one can look at the financials such as the Select Sector Financial (XLF). The longer-term monthly chart is shown in figure 2.

Figure 2

As a group of financial stocks in this sector that make up this instrument you can see the (XLF) is approaching levels close to the lows of the last recession bottom in late 2002 and early 2003. This could suggest we are close to a cyclical bottom. If that is the case then we can see which stocks within that sector perform better or worse. By going one step further a trader can watch for the sector to demonstrate strength and then look at the top five or ten holdings within that ETF. Instead of investing in the actual ETF one could diversify and buy into or explore option strategies such as long at the money or in the calls on individual stocks within that sector. The top six holdings within the (XLF) ETF include American Express (AXP), American International Group (AIG), Bank of America (BAC), Bank of NY Mellon Group (BK), Citigroup (C), Goldman Sachs (GS).